Does Companhia Distribuidora de Gás do Rio de Janeiro - CEG (BVMF:CEGR3) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Companhia Distribuidora de Gás do Rio de Janeiro - CEG (BVMF:CEGR3) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Companhia Distribuidora de Gás do Rio de Janeiro - CEG

How Much Debt Does Companhia Distribuidora de Gás do Rio de Janeiro - CEG Carry?

As you can see below, at the end of December 2020, Companhia Distribuidora de Gás do Rio de Janeiro - CEG had R$1.18b of debt, up from R$999.6m a year ago. Click the image for more detail. However, because it has a cash reserve of R$311.2m, its net debt is less, at about R$863.9m.

A Look At Companhia Distribuidora de Gás do Rio de Janeiro - CEG's Liabilities

The latest balance sheet data shows that Companhia Distribuidora de Gás do Rio de Janeiro - CEG had liabilities of R$1.02b due within a year, and liabilities of R$1.20b falling due after that. Offsetting this, it had R$311.2m in cash and R$499.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.41b.

Since publicly traded Companhia Distribuidora de Gás do Rio de Janeiro - CEG shares are worth a total of R$15.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Companhia Distribuidora de Gás do Rio de Janeiro - CEG's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 15.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Companhia Distribuidora de Gás do Rio de Janeiro - CEG grew its EBIT by 2.3% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Companhia Distribuidora de Gás do Rio de Janeiro - CEG will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Companhia Distribuidora de Gás do Rio de Janeiro - CEG recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Companhia Distribuidora de Gás do Rio de Janeiro - CEG's impressive interest cover implies it has the upper hand on its debt. And we also thought its conversion of EBIT to free cash flow was a positive. It's also worth noting that Companhia Distribuidora de Gás do Rio de Janeiro - CEG is in the Gas Utilities industry, which is often considered to be quite defensive. When we consider the range of factors above, it looks like Companhia Distribuidora de Gás do Rio de Janeiro - CEG is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Companhia Distribuidora de Gás do Rio de Janeiro - CEG , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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